Business Organizations
Exam - Fall 2001
Model Answers and Noteworthy Mistakes
Professor Kleinberger
These model answers have been drafted by the
professor, without time pressure and after reading and evaluating all the blue
books. The model answers reflect a
level of sustained competence and succinctness which no student is expected to
reach under the time pressure of an in-class exam. Many students do reach this level of competence on one or more
questions, but even the best exams typically miss at least one major issue and
sometimes more.
Applicable Law
Unless a problem specifically indicates to the contrary:
1. Any
reference to a partnership means an ordinary general partnership – i.e., not a
limited liability partnership.
2. General
partnerships are governed by the Revised Uniform Partnership Act (“RUPA”).
3. Corporations
are organized under the law of a state (“State”) that has adopted the Revised
Model Business Corporation Act, except as to derivative lawsuits, the special law applicable within close
corporations, and the duties of directors.
a. As
to derivative lawsuits, State slavishly follows Delaware law.
2.
As to the
special law applicable within close corporations:
i.
the following sections of Minnesota Statutes apply: 302A.455, 302A.457 and those portions of 302A.751 contained in
the photocopied materials;
ii.
the courts of State apply § 302A.751 in light of the case law assigned in this
course.
c. As
to the duties of directors, 302A.255 (1992 version;
Photocopied Materials, at 97) applies; otherwise, except as to close
corporations, State slavishly follows Delaware law.
Mention
of these particular statutes does not necessarily mean that they will be
relevant to any of your answers.
Part One
A.
Consider this passage from Phillips v. Corporate Express Office
Products, Inc., 2001 WL 929902 (Fla.App. 5 Dist. 2001):
The
issue in this case is the enforceability of a non‑compete agreement after
[a] stock purchase, merger and name change.
Corporate
Express Office Products, Inc. ("Corporate Express"), sells office
products, furniture and equipment. It sued . . . former employees Phillips and Farrell) and their new
employer, Commercial Design Services, Inc. ("Commercial Design"), for
. . . breach of non‑ compete
agreements. . . .
In 1986, . . . Doug Phillips signed a [non‑compete]
agreement with his employer, Bishop Office Furniture Co. ("Bishop").
In 1989, Lori Farrell signed her non‑compete agreement with Bishop. All
of these agreements precluded the employees from competing against their
employers or soliciting the employers' customers for one year following the
termination of employment. None of the agreements contained assignment clauses.
In 1997, CES purchased 100% of Bishop's stock.
CES did not require Bishop employees to execute consents to assign their non‑compete
agreements to CES. Accordingly, Phillips and Farrell did not execute consents.
CES continued operating Bishop's business under the Bishop name. In 1998,
Bishop merged into its parent company, CES. Shortly thereafter, CES merged into
its parent company, Corporate Express of the East, Inc. ("CEE"). Five
months later, CEE changed its name to Corporate Express Office Products, Inc.
("Corporate Express").
Throughout
the . . . stock purchase, mergers and name changes, . . .Phillips and Farrell
remained employed with the corporation that ultimately came to be known as
Corporate Express. In 2000,. . .Phillips and Farrell terminated their
employment with Corporate Express and began working for Commercial Design,
allegedly in violation of their non‑compete agreements.
Assume that the defendants (Phillips, Farrell and their new employer)
asserted, in essence, that none of the non-compete agreements contained
provisions expressly authorizing assignment and that “the plaintiff here is a
totally separate party from the corporation which was party to the non-compete
agreements.” Based solely on the
topics covered in this course, evaluate that assertion.
Model Answer: The
defendants’ assertion ignores fundamental principles of corporate law and is
therefore wrong.
Bishop was the
original corporate party to the non-compete agreements. CES’ purchase of 100% of Bishop's stock had no effect on Bishop as a legal person
and therefore no effect on the non-compete agreements. (A corporation is a legal person separate
from its shareholders.)
In each of the
corporate mergers, the non-compete agreements transferred to the surviving
corporation by operation of law and, after each merger, the surviving
corporation became party to each agreement.
RMBCA § 11.06(a)(2) (title to all property vests in surviving
corporation).
The name change was
irrelevant to this issue. The identity
of a corporate person does not change when the corporation changes its name.
Noteworthy Mistakes:
ignoring the stock purchase; ignoring the name change; referring to CES’s
purchase of 100% of Bishop's stock as a
share exchange
B. Consider the following
passage from Wilson v. Stock Lumber, Inc., No. C3‑01‑623.,
2001 WL 1182796 (Minn. Ct., App. Oct. 9, 2001):
[This case considers whether,] under the doctrine of respondeat
superior, . . . Stock Lumber, Inc. [“Stock”], is vicariously liable for an
assault committed by its employee in a road‑rage incident. . . .
FACTS
. . .Brent Joseph Rau was an employee of Stock Lumber. When Rau was
hired in April 1997, his driving record included three speeding tickets and
convictions for reckless driving, improper lane change, failure to obey a
semaphore, and fleeing a police officer. [FN1] Rau did not disclose his
complete driving history to Stock before he was hired. [FN2] There was no
evidence that Rau engaged in any assaultive behavior before the road‑rage
incident.
FN1.
The convictions for fleeing an officer and reckless driving occurred when Rau
was between the ages of 18 and 22, six years before this incident.
FN2.
Stock presented evidence that when it hired Rau, it only knew about his
speeding tickets, the improper use of lane, and the failure to obey a
semaphore. Wilson does not dispute that Rau did not disclose his complete
driving record before he was hired.
In October 1997, Rau was
driving on the freeway after making a delivery. Wilson came onto the freeway,
and when he merged into the left lane, Rau was forced to brake. Rau made a rude
hand gesture toward Wilson, and after more gestures by both drivers, they
pulled over to the side of the road and got out of their vehicles. Wilson
approached Rau's truck. Rau assaulted Wilson, injuring him, and left the scene.
Rau was arrested for assault and pleaded guilty.
The trial court held
that, on the stated facts, the claim for respondeat superior liability should
be dismissed on summary judgment. Do
you agree? Explain.
Model Answer: The
trial court is correct. For respondeat
superior to apply, the plaintiff must eventually establish that Rau was a
“servant” of Stock and that the assault was within the scope of Rau’s
employment.
The plaintiff apparently established servant status, because the
opinion refers to Rau as “an employee of Stock.” In the context of a respondeat superior analysis, the “employee”
label is a tantamount to a holding that Rau was a servant.
The plaintiff will not, however, ever be able to establish that the assault
occurred within the scope of employment.
Under the traditional rule, an intentional tort can be within the scope
of employment only if actuated at least in part by the servant’s desire to
serve the master. Rau’s assault clearly
fails this test; he was venting his rage, not serving his employer’s interests.
The more modern test asks whether some special attribute or
characteristic of the servant’s role makes the abusive conduct “incidental” to
the employment – i.e., whether the abusive conduct is foreseeable from the
nature of the employment. When properly
applied, this test looks exclusively to the nature of the employment and
ignores as irrelevant the characteristics or behavior of any particular
servant.
The foreseeability test thus renders Rau’s driving history irrelevant
and compels summary judgment on the plaintiff’s claim. Especially in a world where road rage is
distressingly common, there is nothing which makes a road rage assault
“incidental” to being a delivery driver.
Noteworthy Mistakes:
merely asserting servant status, without any supporting discussion; discussing
whether Rau’s driving (rather than the assault) was within the scope of
employment; doing a “frolic and detour” analysis; omitting the “actuated in
part” analysis; omitting the incidental-foreseeable analysis; analyzing whether
Stock should have foreseen that Rau would commit an assault, rather than
whether the employment itself was a foreseeable source of the danger; analyzing
whether Stock was negligent in hiring Rau
C. Section 801(2) of the
Uniform Limited Partnership Act (2001) provides:
SECTION 801. NONJUDICIAL
DISSOLUTION. Except as otherwise provided in Section 802,
a limited partnership is dissolved, and its activities must be wound up, only
upon the occurrence of any of the following:
. . .
(2) the consent of all general partners and of limited partners owning
a majority of the rights to receive distributions as limited partners at the
time the consent is to be effective;
XYZ is a limited
partnership with three general partners, each of whom is also a limited
partner, and 5 other limited partners.
Rights to receive distributions are allocated as follows:
Partner #1 as
general partner – 3%
Partner #2 as
general partner – 2%
Partner #3 as general partner – 1%
Partner
#1 as limited partner – 7%
Partner
#2 as limited partner – 3%
Partner
#3 as limited partner – 4%
Partner
#4 as limited partner – 5%
Partner
#5 as limited partner – 5%
Partner
#6 as limited partner – 5%
Partner
#7 as limited partner – 5%
Partner
#8 as limited partner – 5%
Several
non-partner transferees, in the aggregate – 55%
1. If Partners 1,2, 3 and 4
consent to dissolve, is the limited partnership dissolved? Explain.
Model Answer: The
following analysis is taken verbatim from the Comment to ULPA (2001), Section
801:
Distribution rights owned by persons as limited partners amount to 39%
of total distribution rights. A
majority is therefore anything greater than 19.5%. If only Partners 1,2, 3 and 4 consent to dissolve, the limited
partnership is not dissolved. Together
these partners own as limited partners 19% of the distribution rights owned by
persons as limited partners – just short of the necessary majority. For purposes of this calculation,
distribution rights owned by non‑partner transferees are irrelevant. So, too, are distribution rights owned by
persons as general partners. (However,
dissolution under this provision requires "the consent of all general
partners.")
Noteworthy Mistakes:
counting limited partners per capita; counting the distributions righted owned
by general partners in their capacity as general partners
2. If Partners 1,2, 4, 5, 6, 7
and 8 consent to dissolve, is the limited partnership dissolved? Explain.
Model Answer: The
limited partnership is not dissolved because the provision requires “the
consent of all general partners.”
Partner 3 is a general partner and has not consented.
Noteworthy Mistakes:
Missing this point
D. Three individuals, Voltaire,
Rousseau and Marat, go into business with the expressed intention of forming a
limited liability company. They fill
out the necessary forms to create an LLC and Marat is given the task of
actually filing the document.
Unfortunately, Marat drops the papers in his bath, is too embarrassed to
tell Voltaire or Rousseau, and never files the papers.
For about a year the
business is conducted as if the papers had been filed. In all its dealings with third parties, the
business styles itself VRM, LLC. After
about a year, Marat and Voltaire discover that Rousseau has diverted almost all
of the company’s assets into a separate company which he owns by himself. Rousseau defends by inter alia
asserting that (i) the company should be treated as a limited liability company
de facto, and (ii) the resulting shield should protect him from personal
liability on Marat’s and Voltaire’s claims.
Evaluate Rousseau’s assertions.
Model Answer: Rousseau is wrong, for two reasons: (1) even
assuming the relevant jurisdiction follows the de facto doctrine, the
facts do not satisfy the doctrine’s requirements; (2) even assuming the
business is treated as an LLC de facto, the resulting shield pertains
only to obligations of the business and has nothing to do with liabilities
resulting from a member’s personal misconduct.
The notion of a
limited liability company de facto comes by analogy from corporate
law. The three requirements are (i) a
statute exists which provides for the formation of the entity and shields the
entity’s owners from automatic liability for the entity’s obligations; (ii) the
entrepreneurs have made a good faith effort to comply with the statute; and
(iii) the entrepreneurs have conducted the enterprise and themselves as if the
entity did exist.
The stated facts
satisfy the first and third requirement, but not the second. Most courts have required at least a filing
of the relevant organizational document.
In any event, dropping the papers in the bath hardly counts as a good
faith effort.
More fundamentally,
a shield – whether de facto or de jure – would not help
Rousseau. The shield protects members
from being liable solely by reason of member status for the obligations of the
entity. Rousseau’s obligation is not “of”
the entity and is not at all by reason of his member status. His obligation is to the
entity for his own misconduct.
Noteworthy Mistakes:
not answering the question at all, but instead discussing the nature of
Rousseau’s duties; mentioning the elements of the de facto doctrine but
not applying them to the facts; missing completely the point that the shield
protects only against obligations of the entity; missing completely the point
that the shield does not protect against personal misconduct; discussing RMBCA
§ 2.04 rather than the de facto doctrine
E.
Under the facts stated in Question D:
1. If
VRM, LLC were de jure a limited liability company, would Marat’s and
Voltaire’s claims be direct or derivative?
Explain.
Model Answer: The
claims would be derivative, because the harm would first affect the LLC. Marat and Voltaire would suffer an
investment loss perhaps, but that loss would occur solely as a result of the
damage done to the LLC when Rousseau diverted the LLC’s assets. Thus, Marat’s and Voltaire’s injury would be
indirect – i.e., assertable only through derivative claims.
Noteworthy Mistakes:
not explaining why the claims would be derivative
2. If VRM, LLC were deemed to
be a general partnership, would Marat’s and Voltaire’s claims be direct or
derivative? Explain.
Model Answer: Under
RUPA (applicable per the Instructions on Applicable Law), the answer is
unclear. RUPA § 201(a) states that a
“partnership is an entity distinct from its partners,” which suggests that the
partnership entity would suffer the direct injury and the partners’ claims
would be derivative.
However, Rousseau breached his duty of loyalty, and RUPA § 404(b)
describes a partner’s duty of loyalty as extending “to the partnership and
the other partners.” (Emphasis
added.) The emphasized phrase suggests
that Marat and Voltaire can bring direct claims.
RUPA § 405(b)(2)(i) goes even further, stating that “[a] partner may
maintain an action against . . . another partner . . . to . . . enforce [the
first] partner’s rights under this [Act], including . . . the partner’s rights
under Section[] . . . 404.” This
language appears expressly to authorize direct claims.
In addition, if Rousseau’s defalcations were to render the partnership
unable to pay its obligations, Marat and Voltaire would each suffer a direct
injury; i.e., each would be personally liable to the partnership’s unsatisfied
creditors.
Therefore, although the entity characterization is to the contrary, it
appears that Marat and Rousseau may assert their claims directly.
Noteworthy Mistakes:
characterizing a general partnership as an aggregate, which is at least
partially true under the UPA but expressly not the case under RUPA; omitting
RUPA § 201(a) and ignoring that provision’s “entity” approach; omitting RUPA §
404(b); omitting RUPA § 405(b)(2)(i)
Part Two
From 1993 until
January 23, 1997, R. Edwin Powell was CEO and president of CAIRE, Inc., a
[corporation] based in Burnsville, Minnesota.
CAIRE manufactures home health‑care products, including portable
oxygen tanks. Powell had worked for CAIRE, a subsidiary of Holdings, for the
preceding 13 years as an at‑will employee. In addition, Powell and the Powell Family Limited Partnership
were minority shareholders in Holdings, owning 63,747 shares or 11.9% of the
company. Trial testimony established
that Powell paid $114,000 to $344,000 for the stock during his employment.
In 1996, a group of
investors decided to acquire Holdings and CAIRE. They formed MVE Investors, LLC (Investors), a Delaware limited
liability company with its principal place of business in New York. Investors,
organized solely to acquire a majority interest in Holdings, purchased the
shares of three retiring Holdings shareholders in August 1996 as part of a
recapitalization of the company. Investors
paid the retiring shareholders $125.456 per share, investing $47 million in
Holdings to become its primary owner.
Powell declined
Investors' offer to sell his stock and retire with the shareholders who had
accepted Investors' offer. Powell
continued as CAIRE's CEO and president.
CAIRE soon suffered financial setbacks, and, in response, David
O'Halloran, Holdings' CEO and president, met with Powell on January 23, 1997,
to fire Powell. O'Halloran gave Powell the option to resign in lieu of
termination, and Powell chose to resign, writing a resignation letter on
January 28, 1997.
The critical factual
issues in this litigation revolve around O'Halloran and Powell's January 23,
1997, meeting. The two men sharply
disagree . . . . on the terms for the disposition of Powell's stock. Powell testified that O'Halloran agreed, on
behalf of Holdings, to buy Powell's stock at the same price that the retiring
shareholders had been paid at the recapitalization that occurred in August
1996. According to Powell, O'Halloran
told Powell that Holdings would be able to buy the shares within a few weeks
and would buy them no later than August 1997.
O'Halloran maintains
that he did not promise Powell that Holdings would buy Powell's stock. [The
trial court resolved this factual dispute in Powell’s favor.]
In August 1996,
Holdings had redeemed other shareholders' stock for the same price O'Halloran
promised Powell. At the time of the
August 1996 recapitalization, with board approval, O'Halloran had signed the
shareholders' agreement on behalf of Holdings, agreeing to buy the shares of
the departing shareholders for $125.456 a share, the same amount O'Halloran had
promised to Powell. . . .
In February and
March 1997, Holdings' in‑house counsel made two separate proposals to
Powell to buy Powell's stock, despite not having prior board approval for those
proposals.
Powell brought this
action against Holdings in October 1997, claiming, among other things, that
Holdings had contracted to buy back his shares and then breached that
contract. Chart Industries merged with
Holdings in February 1999, paying $78 million for Holdings' stock. The merger agreement specified that shareholders
who released claims against Holdings would receive $45 per share, but
shareholders refusing to release claims against Holdings would receive only $25
per share. Powell refused to drop his
lawsuit, and Holdings redeemed his shares at $25 per share, paying him a total
of about $860,000 and retaining about $680,000 for defense costs associated
with Powell's lawsuit. Powell also
received shares of stock in a Holdings subsidiary as a result of the merger.
A. Assume that O’Halloran lacked any actual authority to bind Holdings
to a stock redemption agreement with Powell.
Was Holdings nonetheless bound by O’Halloran’s promise that Holdings
would buy Powell’s stock?
Model Answer:
Probably not.
Powell’s best chance is to assert that O’Halloran had apparent
authority to bind Holdings. To
establish apparent authority, Powell must prove that a manifestation
attributable to the apparent principal (Holdings) led Powell reasonably to
believe that O’Halloran had actual authority to bind Holdings. Powell can point to two manifestations:
O’Halloran’s position as CEO and the fact that O’Halloran signed the August
1996 agreements on behalf of the company.
A CEO has the apparent authority to undertake transactions within the
ordinary scope and course of the corporation’s business, and O’Halloran’s
signature on the 1996 documents indicates that, at least on one occasion, the
corporation had given him actual authority to bind to the corporation to stock
buy-back agreements.
Buttressing the reasonableness of Powell’s belief is the fact that
O’Halloran’s offer to Powell was at the same price as contained in the 1996
documents which O’Halloran had been authorized to sign. (The in‑house counsel’s two separate
proposals to Powell are irrelevant, since they both occurred after O’Halloran
purported to bind Holdings.)
The weakness in Powell’s claim is that he was himself an experienced
corporate officer. As such, he had
reason to know that buying back a shareholder’s stock is not the type of
quotidian transaction to which a CEO may commit the corporation on his or her
own. Powell’s belief in O’Halloran’s
authority was therefore unreasonable, which defeats Powell’s apparent authority
claim.
Powell might also
assert that O’Halloran bound Holdings through O’Halloran’s inherent authority
as a general agent. O’Halloran was
certainly Holding’s general agent – “authorized to conduct a series of
transactions involving a continuity of service,” R.2d § 3(1) – but a general
agent’s inherent authority extends only to “acts . . .usual or necessary” to
authorized transactions. R.2d §
194. Even assuming that Holding’s board
had authorized O’Halloran to fire Powell, committing the corporation to a stock
buy-back at a price dramatically above the stock’s then current value is
neither “usual or necessary in such transactions.” Id.
Noteworthy Mistakes:
not seeing the “authority by position” analysis; not addressing O’Halloran’s
authorized participation in the 1996 buy-backs;
not commenting on the offers by the in-house counsel; not addressing the
inherent authority issue; arguing that estoppel might apply, even though there
are no facts to support that argument; assuming without discussion that a CEO
is reasonably seen as having the authority to buy-back stock
B. Holdings
contended that, even if O’Halloran had bound Holdings to the stock redemption
agreement, “the agreement is invalid because it is in violation of public
policy because the agreement prefers Powell as a shareholder at the expense of
the other shareholders, contravening the ‘equal‑opportunity rule’ found
in Donahue v. Rodd Electrotype Co.”
Evaluate that contention.
Model Answer: The contention is bogus, for at least three
reasons. First, Donahue is no
longer good law, even in Massachusetts, having been overruled by Wilkes. Second, Donahue’s equal-opportunity
rule applied in favor of minority shareholders when the corporation had
redeemed a member of the “control group.”
Powell is a minority shareholder, not a member of the control
group. To apply Donahue to
invalidate Powell’s contract would turn the equal-opportunity rule on its
head. Third, even assuming that the
equal-opportunity rule applied to the Powell buy-back, that buy-back is merely
giving Powell equal opportunity with the shareholders who were bought out as
part of the 1996 recapitalizatoin.
Noteworthy mistakes:
making only one or two of the three available arguments; failing to critique
the assertion that Donahue should invalidate the contract asserted by
Powell – i.e., failing to answer the question asked; discussing Wilkes
at length
C. When Powell
brought his action against Holdings in October 1997, he claimed breach of
contract.
1. Assuming
that Holdings was then a closely held corporation, could Powell have invoked
Minn. Stat. § 302A.751 even though he had been employed by CAIRE not Holdings
and was no longer an employee even of CAIRE?
Model Answer:
Certainly. To have standing under Minn.
Stat. § 302A.751 a person must be a shareholder of the relevant
corporation. Employee status is a
prerequisite to bringing some but not all claims under the section.
Noteworthy Mistakes:
missing the shareholder status issue; discussing Powell’s relationship with
CAIRE; noting that Powell was an employee of CAIRE at the relevant time and
asserting that some form of “alter ego” analysis should apply to collapse CAIRE
and Holdings for the purposes of § 302A.751
2. Assuming
that Powell could have invoked Minn. Stat. § 302A.751, explain his cause(s) of
action under that provision.
Model Answer:
Because Powell’s standing is limited to his capacity as a shareholder, he would
assert that “the directors or those in control of the corporation have acted in
a manner unfairly prejudicial to [him in his capacity as a] shareholder[] . . .
of a corporation that is not a publicly held corporation.” Minn.Stat. § 302A.751, subd. 1(b)(3).
In particular, Powell would re-frame his breach of contract claim into
a claim of unfair prejudice. He would
also claim unfair prejudice in the merger agreement, arguing that the value of
a shareholder’s shares is totally separate from any claims the shareholder
might have against the corporation.
Noteworthy Mistakes:
finding only one of the two possible claims; asserting that Powell had claims
based on his termination, even though he was not an employee of the corporation
in which he was a shareholder
This Part is based on, and some of the
language is taken from, Powell v. MVE Holdings, Inc., 626 N.W.2d 451
(Mn. Ct. App. 2001), rev. denied July 24, 2001.
Reasonable minds might disagree on this
point. I accorded equal credit to well
reasoned arguments in favor of O’Halloran’s apparent authority.
It was not necessary to cite, much less
quote, these Restatement provisions. I
did so here because I found doing so easier than paraphrasing.
I accorded equal credit to any analysis which
treated this fact as relating to the reasonableness of Powell’s belief.
While this analysis is interesting, it
ignores the far simpler and more direct point reflected in the Model Answer.
The facts do not suggest fraud or illegality,
although I accorded equal credit to answers which invoked § 302A.751, subd.
1(b)(2).